Indian markets 'remarkably resilient' despite foreign funds' outflow, says Chris Wood of Jefferies

The big question for this year is, does at any point, the Fed language change to a softer stance? I believe that becomes a greater possibility if not a probability later in the year. However, for now, the Fed is sounding hawkish.

As I said a month ago, a key point to understand is there's political pressure from Washington for the Fed to be seen doing something about inflation because all the opinion polls show that inflation and rising prices are the number one issue concerning Americans.

As for the Euro zone, they've done an equally spectacular U-turn - the ECB. But in the case of the ECB, there's actually a silver lining to higher rates, in my view, because it will liberate the Eurozone banks from the lunatic policy of negative rates. I view negative rates as a negative for an economy and the banking system, actually, perversely, higher rates are positive in the Eurozone.

A: When we go past 30 percent, then I believe the market will be very sensitive to any sign of the Fed backing off.

The other issue, about how we get an overshoot over 30 percent is in a situation where Fed is continuing to tighten and let's say come next quarter, we've had two consecutive quarters of down markets in the US, then when the retail investors get their statements, then I think there's a greater chance that we get significant outflows out of the exchange trade funds (ETFs).

The very big difference between the US stock market and the Indian stock market is, in the last 10 years or more in the US there have been huge flows into these ETFs. Many of these ETFs are linked to indices, most particularly the S&P. At the start of this year, there were more than a trillion dollars linked to S&P index ETFs which means all this money owns the same stocks. And if you start to get major outflows out of that kind of product, then that's how you get an overshoot on the downside.

A: Clearly at the margin growth will be slowing. We see that already in the interest rates, the classic interest rate-sensitive sectors in the US like, like autos, and housing. And that's why some of these cyclical sectors will now become vulnerable, where the growth stocks have already been hit.

I'm not an economist though and at the end of the day, a recession is just a technical definition. But the further you go forward in time, the more likely the US is to enter a recession. So I would be surprised if there's no material evidence, in terms of the data of a slowdown in the US economy, come the fourth quarter of this calendar year.

Probably the most bearish-looking signal we have right now has been a very significant decline in US consumer confidence - more than I would have thought given that there are still high nominal wage gains in America. So the US consumer confidence has weakened dramatically and you wonder if that's linked not only to rising prices but people being hit by the stock market.

The other recent development has been a plunge in the US household savings rate, which I believe is now back to levels from memory of 2012. So these cash buffers, the US households built up partly as a result of the relief - the transfer payments made by the pandemic are now being reduced. And maybe some of these cash buffers may have been lost in the stock market or indeed in crypto.

A: One is growth slowing and financial market damage. But another very important thing is politics. Because as I said, half the reason the Fed did such a dramatic U-turn and has suddenly started talking so hawkish is that,t in Washington, there was suddenly pressure from the moderate part of the Democratic Party and the Biden administration for the Fed to be seen to be doing something about inflation.

For the first time in more than 40 years, we now have pressure on the American central bank from the executive and arms of government for the Fed to tighten. This is something we have not seen for many, many years. However, the nearer we get to the mid-term elections, and if markets are very weak and the economy is weakening, then that pressure from the Democrats might go the other way. And if the pressure starts to go the other way politically on the Fed, then I think based on the track record of the Fed, the chances grow significantly that the Fed softens the language, even though they have unlikely to have met their 2 percent inflation target.

So if the Fed starts to do a U-turn when inflation is still running well above 2 percent that will be basically confirmed that they are going to let inflation be structurally higher going forward and that would be negative for the dollar, bullish for gold, and very negative for treasury bonds, but good for equities.

A: This will keep the inflation story bubbling and keep the pressure on the Fed tightened. So this will make the market assume that the next rate hike will be 50 basis points.

The interesting technical point and it has been becoming evident in the last two months is that the pricing pressures have been moving from goods to services, and inflationary pressures in services are more sticky. So if that is still the trend in the report today then that will create more concern.

However, the problem is that the Fed is so far behind the curve, that if the Fed really wanted to crush inflation, it needs to impose real rates today and obviously, they're nowhere near imposing real rates. So both the Fed and the ECB are massively behind the curve and they basically are in a very unfortunate situation of playing catch up. But while the market is weak, we haven't had a market collapse yet.

A: My advice is you just want to take one meeting at a time like you want to take one CPI because there's no point speculating beyond that as there are too many variables. But I would be amazed if the Fed did not raise rates by another 50 basis points at the next meeting.

Meanwhile, as to the Fed governors long-term forecasts, while they provoke a lot of discussion, we need to remember one simple fact - as recently as last September, more than half the Fed governors in the US said no rate hike at all in 2022. So these forecasts are not really worth anything.

A: This is a point of highlighted by my colleagues in India and I think it's a very valid point. First of all, the remarkable development this year is the continuing pretty dramatic level of FII foreign selling of Indian equities, which by historic standards is as much as we've ever seen. But we've also seen this remarkable staying power of the inflows.

So what's interesting is, last fiscal year, but half of the flows are actually people investing directly in stocks, not through funds. So clearly, as time goes on, and months pass, and on a 12 month rolling basis, people are no longer making gains on their investments, there's got to be a risk if not a probability that the domestic flows reduce.

But having said that, it's remarkable up to now how resilient the Indian markets have been. It's also explained by the fact that India has a very good macro story right now on a 10-year view. We've got a lot of positives, one is the property market having clearly turned up. On my trip this week, we're picking up more anecdotal evidence of a capex cycle coming, but this is a year where the Indian market would do very well to trade sideways so long as the backdrop is Fed tightening and also we have RBI tightening.

Now, the RBI tightening is nothing as dramatically negative as the Fed one, because the RBI is nothing like as behind the curve, though it is behind the curve. So it's good news that they raised rates by 50 basis points this week. But we have the other variables of the food and oil-driven inflation of which the most dramatic is the oil price.

I had a view that oil was going to USD 150 per barrel even before Ukraine because of the supply constraints caused by the attack of the political green lobby on fossil fuels. But clearly, Ukraine has added a whole new dynamic in terms of fertilisers, effect on food prices, etc.

So all this is a negative headwind. And the base case has to be that the Indian market corrects further. However, in my view, a big move up in oil, while will be very negative in the short term is not going to kill the Indian economy like it would have done historically. And as I said, my base case is that the Fed language changes before year-end. I'm not expecting the Fed to be still tightening like this, this time next year. And therefore it's just a question of watching out for that change in Fed language. If I had to guess at the timing of that change in Fed language and is purely a guess it would be late third quarter.

A: In a world where the Fed keeps tightening and in our base case S&P goes down 30 percent or more, to me the sort of level on the Nifty is 14,000-14,500 and I am just saying that on charts because that’s where you look to have support. But it doesn't have to be that bad, if the domestic flows hold up, then there's a potential possible outcome where the Indian market does trade sideways, it is not my base case, but the Indian market trade sideways. And you know the valuations are adjusted by the course of time.

The inflation issue is much greater in America than in India, one, and two, India is an expensive market but US equity market valuations are way more expensive in my view than in India. Most particularly if you look at valuations relative to sales.

A: I've just adjusted it, but nothing dramatic, maybe later. However, I'm perfectly comfortable with the long-term structural story in India. The only risk frankly is just the monetary tightening cycle. The higher rates and delays, the broader capex pick up. But all the evidence is the property recovery is underway. India is a domestic demand-driven story, so that's good news. But history does suggest that the Indian stock market is highly influenced by moves on Wall Street.

But given that foreigners have sold so heavily, the foreigners will be will be looking to buy on any significant correction in India.

The level I identified on the Nifty of 14,000-14,500, if you ever reach that level, it will trigger a lot of foreign buying.

A: That is not my opinion, that's just an observation that there's a dialogue amongst the clients of investment managers, such as pension funds endowments globally, there's a growing discussion of whether it's appropriate to have emerging market mandates ex-China.

Originally, this discussion was driven by the view that China is such a big market, that it merits a separate allocation on its own, and the rest of the emerging markets should be treated separately. But in the recent past, this discussion has turned has taken another form because many people are arguing that China is un-investable, or that the Chinese government no longer likes the private sector.

There are people in the US who are arguing that people should not be investing in global emerging market mandates, including China because China is perceived as the enemy. So this is a discussion underway. But the simple point is if you have a global emerging market mandate, excluding China, then the other markets can become statistically more significant than the benchmark of which India would be one obvious beneficiary.

A: It depends. If the cost of all those higher input costs finally end up being passed on to the consumer, then I'm not sure that's the case, but really depends if they're able to pass the costs on, doesn't it? And I think that's something we need to watch.